When our chief economist and I sat down to write a policy paper on gross receipts taxes (GRTs) last year, we made a surprising discovery. There was almost nothing in the recent public finance literature on gross receipts taxA gross receipts tax is a tax applied to a company’s gross sales, without deductions for a firm’s business expenses, like costs of goods sold and compensation. Unlike a sales tax, a gross receipts tax is assessed on businesses and apply to business-to-business transactions in addition to final consumer purchases, leading to tax pyramiding. es. After a series of studies in the 1940s, the literature was essentially silent on GRTs for almost six decades. And after a little historical digging, we learned why.
It turns out that after a brief surge in GRTs during the Great Depression, the deep flaws in their structure became apparent to academics and lawmakers alike. State and local lawmakers rushed to scale back or abandon the taxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities. es in favor of more well-designed alternatives like sales, income and property taxA property tax is primarily levied on immovable property like land and buildings, as well as on tangible personal property that is movable, like vehicles and equipment. Property taxes are the single largest source of state and local revenue in the U.S. and help fund schools, roads, police, and other services. es. Although GRTs survived in a handful of states, by the late 20th century they had largely disappeared from the policy debate.
As a result, by the turn of the 21st century a whole generation of public finance scholars had passed with essentially no scholarship on the economics of gross receipts taxes. Just as long-extinct species get few mentions in modern zoology texts, few public finance textbooks even mention gross receipts taxes anymore. They’re typically treated as a historical curiosity, mentioned only as an example of bad policy from a dimmer intellectual age on par with mercantilism, cost-push inflation and Peter the Great’s beard tax.
Unfortunately, Illinois Governor Rod Blagojevich and a handful of his paid consultants have almost single-handedly brought the long-discredited gross receipts tax back to life. With the Governor’s recent proposal for a statewide GRT, interest has surged in gross receipts taxes. (See our analyses of the Illinois plan here, here, here, here, here, here and here).
This unexpected rebirth of gross receipts taxes caught many economists off guard. However, as more and more public finance experts have turned their attention to GRTs in recent months there has been an outpouring of fresh scholarship on them. And not surprisingly, we are again witnessing the formation of an intellectual consensus among economists and others that GRTs are a deeply flawed and indefensible tax structure.
Today’s Journal-Gazette has a good sampling of the views of three local Illinois professors on the problems with Gov. Blagojevich’s proposed Illinois GRT:
An economics professor says Gov. Rod Blagojevich’s gross receipts tax will hit businesses like a hike in the gasoline tax affects oil companies.
“If you raise the tax on gasoline are you going to stick it to the oil companies? No, they pass on the tax down the line,” said Paul Fayh, an Eastern Illinois University economics professor.
“And the consumers pay more at the pump,” Fayh explained. “That’s largely what will happen here with the gross receipts tax.”
Fayh was one of three economics or business professors who condemn the gross receipts tax as flawed public policy that will place the final burden for the new tax on small businesses or low-income households.
Blagojevich claims his Tax Fairness Plan that introduces the gross receipts tax would “level the playing field” for smaller businesses by placing a new tax responsibility on businesses with more than $2 million in annual sales. The estimated $8 billion-plus revenues collected from the gross receipts tax would direct new money to education and health care programs in Illinois.
No one argues that the gross receipts tax would not generate a lot of money – it is touted as the largest tax program in Illinois history. But the debate is that the wrong people or businesses will be paying the tax at the cash register, not big businesses that the governor says pay little or no state income taxes.
That will produce price shocks at the cash register for Illinois residents least able to afford it.
“A gross receipts tax is comparable to a sales taxA sales tax is levied on retail sales of goods and services and, ideally, should apply to all final consumption with few exemptions. Many governments exempt goods like groceries; base broadening, such as including groceries, could keep rates lower. A sales tax should exempt business-to-business transactions which, when taxed, cause tax pyramiding. . They are not identical, but they are comparable. And economically, a sales tax hits low-income people the hardest. So a big portion of the gross receipts tax burden will fall on low-income residents,” said Fayh. “The governor says he is protecting middle-income people in the state. But people of little income will be hit the hardest.”
University of Illinois economics professor Fred Giertz states the GRT plan is “a textbook case of an inefficient tax that penalizes smaller businesses that depend on outside vendors.” His remarks were published in the State Tax Notes newsletter and distributed by the University of Illinois News Bureau this week.
“A small firm would have to pay taxes on its payments to lawyers, accountants and janitorial services, while a large firm that provides for these activities in-house would escape the tax,” wrote Giertz, who is with the Institute of Government and Public Affairs in Champaign-Urbana.
At the same time, by exempting firms with $2 million or less in yearly sales, the plan would create “equity problems,” according Giertz. He said a lawn-care company employing 40 low-wage workers would be subject to the gross receipts tax if its annual sales exceeded $2 million, but a four-partner law firm with annual receipts of $7.9 million could escape the tax by becoming four independent practitioners sharing an office.
A gross receipts tax would especially hurt Illinois businesses whose purchases and production are in-state, Giertz said. These companies would be subject to “pyramiding effects” as the tax is imposed “on the same input again and again through the production process.” By contrast, an out-of-state vendor selling into Illinois would only have to pay the gross receipts tax once – at the final sale.
Eastern Finance professor James M. Jordan-Wagner said the choices for businesses would be twofold.
“You have to understand businesses don’t pay taxes, they are collectors,” said Jordan-Wagner, who is an interim chair in the Lumpkin School of Business. “Businesses will raise their prices to compensate for the taxes or they will move.”
He lives in Paris so he knows some businesses will look to Indiana for an address change if the gross receipts tax is approved in Illinois.
“For some businesses there you’re only talking about a move of nine or 15 miles. And this tax certainly doesn’t do anything for small businesses. Illinois has not come to grips with the fact that most of the future rests with small businesses. If you have a 10 percent profit margin and your sales are just above $2 million your profits are not that great. And the profit margin is even lower for businesses like groceries or those selling commodity items,” Jordan-Wagner said.
Giertz and Fayh believe a more realistic increase in revenue is through the state income tax.
“A modest rate increase in the income tax (individual and corporate), accompanied by an increase in the exemption level to protect low-income taxpayers and the expansion of the sales tax baseThe tax base is the total amount of income, property, assets, consumption, transactions, or other economic activity subject to taxation by a tax authority. A narrow tax base is non-neutral and inefficient. A broad tax base reduces tax administration costs and allows more revenue to be raised at lower rates. to include consumer services, would generate sufficient funds for the state to address its fiscal imbalance if the extra funds were accompanied by spending discipline,” Giertz wrote.
“The governor is blaming the corporations for taking advantage of the tax system. If that’s the case then rewrite the income tax laws! But that will face a lot of opposition and it would take years. And that’s the reason it won’t happen. This gross receipts tax is much more politically appealing for the governor by claiming he is taking on the big corporations. But that is all smoke and mirrors.”